Unwise Investments

personal finance

December 28, 1998|BY BILL DEENER The Dallas Morning News

Millions of U.S. workers think they are saving for a cushy retirement through monthly contributions to company 401(k) plans. But evidence is mounting that poor investment decisions by many 401(k) participants may ultimately dim their golden years.

While some employees have the savvy to build a reliable retirement nest egg, many others don't have the time, knowledge or inclination to properly manage their 401(k) plans, retirement experts say. Left by their employers to fend for themselves, some invest far too much in ultra-conservative money market and bond mutual funds or "chase returns" by making risky moves into aggressive international and small-cap funds.

As a result, these experts say, a large number of Americans may find they haven't put away enough money to retire comfortably when they reach 65 -- with no traditional company pension plan to fall back on. One recent study of 401(k) plans found that participants' portfolios performed only half as well as the overall stock market.

And it isn't just the workers who are at risk. Experts say companies are leaving themselves vulnerable to future employee lawsuits if they continue to ignore the problem.

"Trying to make all employees money managers is inherently flawed and will lead to disaster," warns Robert Markman, a Minneapolis money manager and retirement expert, who likens it to trying to make them all doctors or professional athletes.

Created in 1978

Named after the relevant section of the Internal Revenue Service code, 401(k) plans were created by Congress in 1978 as a way for working Americans to save money for retirement. Plan participants can set aside up to 15 percent of their pretax income, investing it in a menu of options ranging from money market funds to more aggressive stock and bond mutual funds and, perhaps, the stock of the companies they work for.

No taxes are paid on the investment returns until the money is withdrawn during retirement, when the plan participant will presumably be in a lower tax bracket.

Today, there are more than 200,000 401(k) plans with about 25 million participants and assets of nearly $1 trillion.

In many cases, company-sponsored 401(k) plans have replaced traditional corporate pension programs. With old-style pensions, known as defined benefit plans, the money is contributed by the employer, who generally hires a money manager to invest the funds.

The crucial difference is that, under a defined benefit plan, the employee is promised a set amount of money during retirement, no matter how well the pension plan's investment portfolio performs. With a 401(k) plan, the employee is responsible for his own investment decisions. And if he makes the wrong choices, or if the stock market goes against him, the 401(k) account may not be able to finance a comfortable retirement or any retirement at all.

And therein lies the problem. Recent surveys show that significant numbers of investors don't know the difference between a money market fund and a stock fund or, in some cases, a stock from a bond. And despite an onslaught of financial information, the situation is getting worse. A 1997 Merrill Lynch survey showed that 50 percent of investors considered themselves knowledgeable about investing vs. 67 percent in 1994.

Reliable statistics on the investment performance of 401(k) participants are hard to come by because most companies that sponsor plans don't track individual returns, said Brooks Hamilton, a Dallas attorney and adviser to several large 401(k) plans.

However, Hamilton recently was given access to the performance records of six big 401(k) plans, and what he found was disturbing: There was a huge gap in performance between the top 20 percent of employees and those in the bottom 20 percent. Participants who made the smartest investment choices for their 401(k) plans reaped returns of 28 percent in 1997, while those who made the most ill-advised decisions earned a paltry 6.5 percent, Hamilton found.

With a 6 percent average annual return, a participant who invested $2,000 a year and increased the contribution 10 percent a year for 30 years would accumulate $675,737. But with a return of 12 percent around the market's historic performance the nest egg would have grown to $1.7 million.

What's worse, the best performance was concentrated among the workers who arguably need it the least -- those making the highest salaries. Hamilton found that the average salary of those in the top 20 percent was $52,123, compared with an average salary of $30,883 for those in the bottom 20 percent.

The reason? Upper-tier wage earners typically subscribe to financial magazines, probably have more college education and are generally more experienced investors than those at the bottom, Hamilton said. This is especially troubling, he said, because the low yields are striking those least able to afford it.